What Is A 72t Distribution?
This episode discusses a little-known option for retirement accounts: a 72(t) distribution.
These are also called substantially equal periodic payments (SEPP).
While distributions from pre-tax retirements will be taxable, these distributions can allow withdrawals from an IRA or old 401(k) before age 59½ without the 10% early-withdrawal penalty.
Tom pushes back on social media framing 72(t) as a clever early-retirement strategy. Tom argues 72t distributions are often a last-resort lifeline for people who truly need access to funds.
The rules are strict. And making mistakes with 72t distributions can be easy. We suggest anyone considering a 72t distribution to seek professional help. There are several ways someone considering a 72t distribution can screw up. There’s only three calculation methods.
Payments must continue for the longer of five years – or must continue to age 59½. Again, whichever is longer. Tweaks like adding money to the account, taking extra distributions from the retirement account, or deciding to skip a year can trigger disqualification of the plan.
If the plan gets disqualified, the 10% penalty on all distributions….. plus interest, will be applied retroactively all the way back to include all distributions made under a 72t distribution.
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Transcript for “What Is A 72t Distribution?”
There’s been plenty of talk on social media and on YouTube about using a 72t distribution as a bridge to allow folks to retire early.
Or to access their retirement accounts early.
I object to how this gets portrayed on these channels as a “strategy” to access cash like that.
It’s not a strategy at all, in my opinion.
For the people who need a 72t distribution, this is a lifeline.
It’s a last resort for many of them.
So let’s talk about what a 72t distribution is.
It’s a way to withdraw money from your retirement accounts….. think an old 401k or your IRA…… without having that pesky 10% penalty applied if you’re taking money out before age 59 and a half.
Of course, if you’re over 59 and a half, this is not an issue.
Any distribution from a retirement account, a pre-tax retirement account, is going to generate taxable income.
But it’s that 10% “whack” on top of it that really causes more damage than it should.
A 72t distribution is sometimes referred to as “substantially equal periodic payments,” or they use a terrible acronym, SEPP.
Suppose you retired well before age 59 and a half.
Or suppose you were let go, downsized, prior to age 59 and a half.
And you want to…… or need to….. tap into your retirement fund.
A 72t distribution permits you to do this without that 10% penalty.
They came up with the name 72t distribution because it stems from Section 72t of the Internal Revenue Code.
Now look, if you do these distributions properly, you won’t have that 10% penalty that usually comes if you’re withdrawing funds prior to age 59 and a half from a retirement account.
But the rules on a 72t distribution are strict.
We don’t advise flying solo on this.
Seek professional help.
You shouldn’t be “winging it” when it comes to making a 72t distribution.
Because if you make an error, all the distributions, all of the distributions…… will be subject to that 10% penalty.
So, more taxable income, more cash out of pocket, all of them retroactively, plus interest. Going all the way back to the very first distribution that you made.
And for the record, it’s EASY to make errors.
Here’s a few situations where people get tripped up.
There’s three…… and only three….. methods to calculate what you’re going to be taking on an annual basis.
If you screw up this math, you’re in trouble.
The calculations are a little complicated, so we’ll save that for another video.
But you have to take distributions, this is tricky, you have to take distributions for five years, or up to age 59 and a half.
But here’s the catch….. whichever of those is longer.
Let me give you some examples.
If you start a 72t distribution at age 50, you’re talking about nine and a half years of distributions.
Remember, it’s five years OR age 59 and a half, whichever is LONGER.
If you start at age 55, you’re talking about five plus years of distributions.
55, 56, 57, 58, 59. Okay?
So at least five years, and maybe a sixth year.
If you start at age 57, you STILL have five years of distributions that you’re going to have to make.
You have to do at least five years or age 59 and a half, whichever is longer.
So if you start at 57, 58, 59, 60, 61, and maybe 62.
If you roll additional money into this account……
Or if you make future contributions to this account, that’s considered a modification to your 72t distribution.
That disqualifies the plan.
If you take an extra distribution in one year, not permitted!
That’s also considered a modification and this would also disqualify the plan.
We read recently someone said, “Hey, we inherited money this year, so we don’t really need to take that 72t distribution this year.”
Not permitted.
Uh, that disqualifies the plan.
And the penalties….. if you modify your 72t distribution can be pretty harsh.
If there’s been any modifications at all to the Rule 72t distribution plan, all of the distributions will be subject retroactively to that 10% penalty.
Plus interest is going to get piled on top of all of that.
So the penalties can be pretty stiff.
There is one tweak where you’re allowed one time to change the method of calculation when you’re making distributions.
As far as we know, that’s the only exception that we’ve seen where you can modify a plan.
In my experience, the folks who need access to these retirement funds before age 59 and a half truly NEED this money.
They don’t WANT this money, they need it.
And so I object to the way this gets portrayed on social media as a “strategy” to access your cash.
I’ve seen 72t distributions more as a lifeline, a last resort…… for folks who truly need the money.
This isn’t something that I think people should plan around.
You should absolutely bring your accountant and your financial advisor in on your plans if you’re thinking about a 72t distribution.
And while pensions and social security can create a “floor” for income during your retirement….. these decisions are one-way doors.
Meaning once you make the choice, it’s very hard to backtrack.
And when folks are wrestling whether to make a 72t distribution, knowing your other options in retirement becomes very important.
For more on that, watch this video next………
